Public Financial Management and Its Emerging Architecture

M. Cangiano, Teresa Curristine, and Michel Lazare

• Publisher: INTERNATIONAL MONETARY FUND
• Year: 2013
• eBook ISBN: 9781475531091

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Part I. An Overview of Contemporary Public Financial Management Reforms

Chapter 1: Reflections on Two Decades of Public Financial Management Reforms

Allen Schick

This chapter provides an overview of contemporary public financial management (PFM). In doing so, it prepares the ground for the succeeding chapters, which discuss in detail specific PFM reforms and challenges. It frames PFM within a logical structure that links (1) the major innovations and reforms (fiscal rules, medium-term budget frameworks, risk management, and performance budgeting) to (2) the core objectives of PFM (to maintain a sustainable fiscal position, effective allocation of resources, and efficient operation of public services), and to (3) PFM levers or instruments for changing behavior and outcomes (information, processes, and rules). The major innovations discussed in this chapter seek to address one or more of the core PFM objectives and to apply one or more levers to change the incentives and behavior of politicians and public servants.

PFM reforms employ new information, process adjustments, and constrictive rules as levers for changing behavior and outcomes. Reform arguably adheres to a logical sequence, beginning with enriching the information available to policymakers (expecting that better information will produce better outcomes), then using processes to induce policymakers to make prudent and effective decisions, and culminating in rules proscribing or prescribing appropriate actions. This chapter applies similar questions to each innovation: Do adjustments to information suffice to achieve desired outcomes? Is it appropriate and necessary to establish formal rules? The chapter also examines how the basic PFM infrastructure—accounting, budgeting, and organizational frameworks supporting the management of public money—has been modernized.

This chapter draws on insights discussed in the other chapters. In line with the overall theme of this book, its aim is not to propose new reforms, but to identify good practices and to assess issues in implementing and melding them into a comprehensive PFM framework. The success of reforms depends in large measure on whether they become institutionalized as the means of managing public finance. Some PFM reforms have taken root—others have not, because implementation has been ineffective, they fit poorly within existing PFM structures, or they were not embraced by those responsible for making them work.

PFM reforms have been stress-tested by the global financial and economic crisis. The test lies not so much in crisis-induced responses but in the actions and policies in place before the crisis, when countries made program and budget decisions that ignored future costs and risks. In some advanced economies, the crisis highlighted institutional weakness and the need to reform existing institutions or introduce new ones. This story is still unfolding.

This chapter is divided into six sections. The first maps a PFM framework and examines PFM core objectives; the second looks at the three key PFM levers and instruments; the third assesses major PFM reforms and evaluates them according to changes to information, processes, and rules; the fourth addresses approaches to modernizing the basic PFM infrastructure; and the fifth discusses critical issues in reforming PFM, including differences in the capacities of advanced economies and low-income countries and whether contemporary PFM reforms can change incentives, behavior, and substantive outcomes. The final section discusses PFM and the global financial and economic crisis and what lessons can be learned for the next generation of PFM reforms.

1.1. Mapping The PFM Framework

PFM is often regarded as an umbrella term for a variety of loosely related processes for managing government finances, including one set of processes for estimating economic conditions and prospects, another for allocating public money, and a third for reporting financial results. PFM sprawls across many fields and practices. It draws from economics and public finance, accounting and auditing, policy analysis and program evaluation, public administration, political economy, and political science. These fields (and others) contribute to managing public finance, but they are rooted in different professional orientations and skills.

A unifying PFM framework must cover major policy questions, such as the fiscal position of government, as well as operational issues, such as the provision of specific services. The framework must be useful to practitioners but must also provide a basis for scholarship and research.

Possible frameworks include the categories on which IMF and Public Expenditure and Financial Accountability (PEFA)¹ diagnostic tools and surveys are based. Although they differ in approach, these diagnostics share a critical assumption—that there is a right way to manage public finance, not necessarily best practice, but better than that achieved by many countries. The IMF Code of Good Practices on Fiscal Transparency² identifies four sets of criteria for one aspect of PFM: clarity of roles and responsibilities, an open budget process, public availability of information, and assurances of integrity. PEFA has six somewhat different categories: credibility of the budget; comprehensiveness and transparency; policy-based budgeting; predictability and control in budget execution; accounting, recording, and reporting; and external scrutiny and audit. Both instruments have been widely and effectively applied in assessing PFM capacity and in prodding governments to upgrade their practices. However, their focus on process calls into question their utility as the organizing framework for PFM.

Good process is essential in PFM to avoid defective results. Budgets that exclude or misreport expenditure will generate deficits above planned levels; governments that lack the means to evaluate programs will have portfolios of ineffective programs; and service-providing agencies that have inaccurate accounts or poorly trained staff will deliver inferior services. Yet, quite a few governments have comprehensive budgets and accurate accounts but excessive deficits, evaluative capacity but rigid budgets that impede a shift of resources to more productive uses, and a rich array of performance measures but inefficient services. In other words, a good process can also produce bad outcomes. Although processes matter a great deal in PFM because they generate and transmit information that shapes the behavior of key actors, they are inherently insufficient because PFM is an open, permeable system, the outcomes of which are swayed by numerous external events and pressures. Precisely because the process is not determinative, assessing the degree to which outcomes fulfill the purposes served by good financial management practice is essential.

1.1.1. PFM Objectives

These purposes have been distilled since the mid-1990s into PFM’s three basic objectives, which are arrayed from highly aggregate policies to discrete actions.³

Government Should Maintain A Sustainable Fiscal Position

The balance between revenues and expenditures, the debt level, and other fiscal aggregates should promote economic stability and be sustainable during the medium term and beyond.

This objective may denote that the aggregates should not simply be the sum of revenue and spending actions, but that firm limits, set in advance, should drive budget decisions through top-down procedures that constrain spending bids. This objective is not well served by annual budgets that measure policy implications only for the year immediately ahead, or by the cash basis of accounting that recognizes only liabilities for which current payments are made.

Various PFM innovations detailed in this and later chapters contribute to this objective, including fiscal rules and frameworks, the accrual basis, medium-term expenditure frameworks, long-term sustainability projections, baseline estimates, fiscal risk analysis, statements of contingent liabilities, and independent fiscal projections and assessments. One of the critical questions facing PFM architects is whether this crop of innovations sufficiently counters economic and political pressures.

Effective Allocation Of Resources To Sectors, Ministries, And Programs

Public money should be allocated on the basis of evidence of program effectiveness and in furtherance of the priorities of government.

Achieving this objective has been hampered for decades by the entrenched incrementalism of public budgets.⁴ Efforts to explicitly reallocate funds from less to more effective uses have not been notably successful, nor has a parade of reforms been able to weaken incrementalism’s hold on budget policy. In many countries, the spread of entitlement programs has made the national budget more rigid and less amenable to reallocation than was the case several years ago.⁵ Governments invest more in policy analysis and program evaluation than in the past, with usually only a marginal impact on allocations.

Medium-term budget frameworks are the main innovation for countering this predicament. These frameworks seek to protect future fiscal space against incremental pressures and give politicians and program managers incentives to reallocate resources within constrained budget targets.⁶ Contrary to past reforms that tried and failed to uproot incrementalism, medium-term budget frameworks concede that budgets are based principally on past expenditure, but aim to significantly expand the margin for reallocation. Strategic planning, program budgeting, outcome indicators, bidding funds, forced cutbacks, and fundamental expenditure reviews have been introduced or retooled to promote effective allocation. Despite these innovations, reallocation may be the most difficult PFM task.

Efficient Provision Of Public Services

Government should achieve value for money in delivering public services and should be attentive to the quality and accessibility of services.

Services are critical points of contact between citizens and government. Citizens know government by way of the services it provides or fails to provide. The depressed level of trust and confidence in governments and leaders has spurred efforts to improve service delivery, and has exerted pressure on governments to do more without increasing tax burdens. Improving public services extends beyond PFM to the overall competence and orientation of public management, especially to the motivation and performance of public employees.⁷ In fact, fundamentally reorienting public management, including financial management, has been new public management’s (NPM’s) principal objective (see Box 1.1). It may be feasible to improve public management without embracing NPM doctrine, but it almost surely is not feasible to transform the way government manages its finances without also changing the way government manages its staff.

Box 1.1 Age Of Innovation: New Concepts And Approaches In Public Financial Management

The end of the postwar boom occurred when governments in advanced economies were becoming sensitive to the financial stresses of aging populations and to the future costs of the pension rights and health benefits they had conferred on citizens during the good times (Tanzi and Schuknecht, 2000). Another, almost concurrent, development was a significant decline in citizen trust in national leaders and institutions (Pharr and Putnam, 2000; Dalton, 2004). These trends impelled some governments to explore new means of managing the public sector, chiefly through innovations that came to be labeled new public management (NPM), and some to import market methods and practices into public management. Significantly, though they were anchored in different principles and orientations, managerialists and marketers found common cause in PFM innovations.

During the past 30 years, many advanced economies have adopted PFM innovations, but few have implemented a full suite of reforms. Moreover, few have embraced the tenets of NPM or market instruments;^a instead, they have favored innovations (e.g., performance measurement, accrual accounting) that can be grafted onto existing PFM arrangements and require no fundamental realignment of financial management. Market and managerial doctrines make demands that most governments find impractical or unacceptable. Market-oriented reforms strive to introduce prices, competition, and choice in the provision of public services. These include governments having the option of purchasing services from public or private providers, a shift from career to term public employment, fees for various services, and the right of citizens to opt out of certain public services. This is not an appealing menu of reforms for governments that have grown on the conviction that public services should be publicly provided. When market-type reforms have been suggested, strong opposition has come from many quarters, especially from public employees and civil service unions. Piecemeal market-oriented reforms have been adopted in some countries, but the overall record has been disappointing to those who believe that without genuine competition and choice, government performance will inevitably be suboptimal.

Managerialist innovations have fared somewhat better, if only because they reinforce the idea that public services should be publicly provided. Unlocking managerial potential by deregulating administrative and financial controls is a cornerstone of NPM, as is stronger accountability for actions and results. NPM purports to “let managers manage” by liberating them from inefficient constraints and procedures and to “make managers manage” by reviewing their performance against expectations. Managerial innovations include global operating budgets that permit managers to decide the inputs they purchase, strategic plans that set objectives, and performance targets that notify managers of what is expected of them. Managerialism has advanced furthest in well-run governments with a high-performing public service, low levels of corruption, and little political involvement in administrative matters. Countries that lack these enabling conditions cannot safely devolve managerial responsibilities from the center of government to operating units, but they can adopt selective performance-improving innovations.

Although they have provided ideas and momentum for innovation, neither market doctrine nor managerialism provides a fully satisfactory architecture for PFM practices. Few governments have fully devolved financial control to spending units, and fewer have mar-ketized public services. A structure that excludes most countries might provide useful ideas for reform, but cannot fuse all relevant elements of financial management into a comprehensive template. The market and managerial designs share a more fundamental shortcoming: neither deals with the aggregate fiscal position of government—total revenues and expenditures, the financial balance, and the debt level. In short, they do not deal directly with deficit bias. Governments have had to seek other means for regulating fiscal policy, such as fiscal rules and medium-term budget frameworks.

^a The concepts and applications of NPM are critiqued in Pollitt (2000) and Talbot (2010).

Efforts to improve services have been centered on performance-oriented initiatives, including output targets and indicators, performance budgets and performance contracts, performance-related pay, efficiency savings that assume ongoing productivity gains, and performance reports and audits. Accrual accounting along with strengthened internal control and audit capacity and integrated financial information systems have also been on the PFM reform agenda. Whether this impressive list of innovations has changed the culture of public management is an open question.

Although they have political aspects, the foregoing objectives are drawn from economic concepts and research. PFM also has an explicitly political dimension—managing public finance not only pursues sustainable public finances and efficiency but also encompasses responsiveness to citizen preferences and enhanced accountability and democratic institutions. Box 1.2 provides a brief discussion of approaches to strengthening financial accountability.

1.2. Pfm Levers And Instruments

This section examines the three key levers of PFM: information, processes, and rules. Achievement of PFM objectives depends on those who manage public finance—p...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• Foreword
• Acknowledgments
• Abbreviations
• Introduction: The Emerging Architecture of Public Financial Management
• Part I An Overview of Contemporary Public Financial Management Reforms
• Part II Designing and Building: Pfm Innovations and Reforms
• Part III Strengthening The Foundations: Modernizing The Pfm Infrastructure
• Part IV Adapting to The Environment: Pfm Reform in Developing Countries
• Footnotes